Suicide by Sequestration

John T. Harvey
, ContributorI want to explain how things work, not what you should believe.Opinions expressed by Forbes Contributors are their own.

U.S. Senate Minority Leader Sen. Mitch McConnell (R-KY) (C) speaks to the media after a weekly Senate Republican policy luncheon at the U.S. Capitol, February 26, 2013 in Washington, DC. The Republican leadership spoke about the GOP agenda and the possibility of sequestration and its economic impact. (Photo by Mark Wilson/Getty Images)

The comedy of errors being played out in Washington would be funny were it not for the fact that the real victims will be well outside the Beltway. Estimates of the job loss from sequestration range from 750,000 to 1 million. Not a single one of those will be from the individuals responsible for this debacle.

For those who are unaware, sequestration is basically the Fiscal Cliff: Part Two. The latter was a set of automatic and draconian budget cuts and tax increases that were supposed to go into effect in January 2013, if the President and Congress didn’t agree on alternate means of reducing the budget deficit. This was never resolved, only delayed until this Friday under the new title of “sequestration.” The hope was that a new solution could be hammered out in the interim. No such luck, so here we sit again, waiting to see if the Democrats and Republicans can compromise or if federal spending is slashed by $1.2 trillion over the next ten years ($85 billion this year). We will lose employees from education, the military, law enforcement, courts, national parks, and more. The economy will almost certainly fall back into recession, long term growth will be stunted, and confidence will be shattered.

And this helps how?

It doesn’t. There is no controversy regarding the disastrous short-term effects. A Google search for sequestration and economic impact yields article after article offering estimates of the large scale cost along with how it will hit individuals like the elderly and children with disabilities. But what’s even worse is that there is no long-term payoff, either. The idea that we have a debt and deficit problem is patently false. The real issue is that there is insufficient demand for goods and services. The way to fix this is, not surprisingly, to increase demand. Throwing hundreds of thousands of government employees and private-sector contractors out of work is not going to help anyone’s sales.

As suggested above, many others have already gone into detail on where cuts will hit and how bad it will be. But, the overwhelming majority of this has been written based on the assumption that we do, in fact, need to cut the debt and deficit, just not this way. I therefore want to do what I’ve done so many times before in this blog: explain why this is a false and terribly dangerous premise. ANY reductions in the deficit are a mistake, not just those forced by sequestration. Below, I attack a number of the fallacies on which these contrary opinions are based (many of these have appeared before in this column–I’ll keep repeating it until President Obama listens!):

If we don’t reduce the national debt, the US could default: This is the biggest fallacy of them all. Every penny of US debt is owed in a currency we are legally permitted to print. There is ZERO chance that we could be forced to default. We may choose to do so (just as a person in a room full of food could choose to starve), but that would be foolish. Greece, on the other hand, could indeed default, since they owe their debt in a currency they don’t control (there are, incidentally, many other reasons why the US and Greece are not analogous, but this one is key). For a longer explanation see It is Impossible for the US to Default.

China controls our economy because we owe them so much money: It must be made clear that US debt to China has nothing to do with the federal government budget deficit and everything to do with the trade deficit. Even if the US government were in surplus, we would owe as much to China because our debt to them is simply the difference between how much we exported to them and how much we imported from them. They then take those excess earnings and use them to buy financial assets. That we had large budget deficits only served to make a particular financial asset–Treasury Bills–available to them in large quantities. We never needed China to buy these to finance the deficit because (in a roundabout fashion) we could always have monetized debt (i.e., sold the Treasury Bills to the Federal Reserve for brand new cash–see below for why this is not inflationary). The one thing we still don’t import from China are dollar bills! If they wanted all the money back tomorrow, we could just print it up and ship it over. China does not own the US, and they desperately need us to grow if they are going to make it because they have very little domestic demand to generate growth and are dangerously dependent on exports.

The debt must be repaid: We must, of course, meet the “monthly payments,” but the level of debt need never be zero. The government has an infinite life span, so there is no day of reckoning when all debts must be settled. And since the debt is owed in dollars, there is never any question that we have the ability to repay since we are allowed to issue brand new ones at any time. Nor is this necessarily inflationary, as explained in the next fallacy.

Deficit spending could create inflation: Yes, it could, if we were already at full employment (unemployment around 4%). In that case, the government would be competing for resources in an economy where no excess existed–that might drive up prices (just as it would have in World War Two had it not been for wage and price controls and rationing). But we are a long, long way from that right now.

Cutting government spending frees up resources for the private sector to grow: It might do so if we were already at full employment and using all our productive capacity. However, in the midst of the worst recession since the Great Depression, this argument holds no water whatsoever. We have plenty of idle resources, the private sector is simply choosing not to employ them. There is no need to free up something that is already in excess supply. Nor is there some web of regulations and taxes that is preventing recovery. The past thirty years has been a continuous deregulation of our economy and effective tax rates as a low as they have been since before World War Two.

The government cannot create jobs: Of course it can. In what sense are police officers, firemen, Marines, soldiers, teachers, national park rangers, FBI agents, and federal court judges not doing a job? A detective undertaking a murder investigation is not working? A CIA agent searching for Al Qaeda operatives is not providing a useful service and simply sucking at the teat of the private sector? Truth be told, not only are these very often hard-working and widely-admired individuals who are doing things that are of great social value, but when they go to the store or a restaurant, they create jobs for those in the private sector, too. For more on this, see Of Course the Government Can Create Jobs.

Cutting the deficit by reducing spending puts money in my pocket: This ignores the fact that a) you weren’t being taxed to finance the deficit in the first place (or it wouldn’t have been a deficit) and b) government spending is money in someone’s pocket. Thus, cutting the deficit by reducing spending actually removes money. This is true even if you are in the private sector, since those government employees bought groceries, paid rent, went to the mall, etc., etc. They earned income for you by buying what you sell. As we lay off all these government workers, the private sector will suffer terribly.

We have largest debt in the world: According to the CIA Factbook, as of 2010 we ranked 37th. That put us behind the world average, Spain, The Netherlands, Austria, the UK, Israel, Germany, Portugal, France, Ireland, Belgium, and Japan.

Government surpluses help the economy grow: In fact, surpluses represent a net drain on private-sector income. Think about it: what would happen if the government spent zero but still collected taxes? That’s what a surplus is, an excess of tax revenues over government spending. We would be bleeding wealth from the private sector and giving it to the public sector. Economic growth creates government surpluses (because tax revenues rise and public support spending falls), not the other way around.

For God’s sake, we have so many difficult problems facing us today. Why add to that by shooting ourselves in the foot–no, the head–by purposely reducing economic activity even more? To see how well this brilliant economic-recovery strategy works, just look at Greece, Spain, and the UK. Better yet, look at the US in fourth quarter of 2012. That negative growth, correlated as it was with a big drop in government spending, is a precursor of things to come.